Shareholders may prefer business results which show consistent year on year profit even if the average or expected profit is less
Increase profitability
If a good price is obtained for re-insurance then it can increase profit
Improve solvency margins
Reducing the volatility of the claims experience reduces the capital needed to support risk and so improves the solvency of the insurer
Increase capacity to accept risk
Improved solvency of the insurer means that additional business can be written potentially increasing the profit realised
Availability of expertise to develop new markets and products
Re-insurers are often very large insurers themselves and have considerable in-house expertise in many markets. This expertise can be made available to the ceding insurer as part of the contract.
Video
Facultative Reinsurance
Each risk is offered individually
No duty on ceder to offer risk
No duty on reinsurer to accept risk
Advantages
Allows each risk to be re-insured on its own terms
Enables insurance company to perfectly match its insurance needs
Disadvantages
Time consuming and costly
No certainty cover will be offered
Price and terms may not be acceptable
May have to speak to reinsurer before accepting a large risk
Usually only used for large one-off risks
Treaty Reinsurance
Usually arranged so that both:
The insurer is obliged to pass on some of the risk
The reinsurer is obliged to accept the risk
Treaty will set out terms on which risk is passed from ceder to reinsurer
Occasionally treaties are written on a facultative/obligatory basis:
Ceder has choice
Reinsurer is obliged to accept risk
Advantages
Re-insurer guarantees to accept business on terms set out in treaty
Disadvantages
Lack of flexibility
Insurer may prefer not to re-insure some risks on the defined terms
Bulk of re-insurance is provided this way
Reinsurance Methods
Note: Finite Risk Re-insurance
Finite Risk re-insurance comes in various forms, but it is essentially structured as reinsurance from a legal point of view but not from an actuarial points of view.
For example, if you buy reinsurance for a tranche of risk where claims are certain then you pay the premium at the start and get the guaranteed claim at the end.
So it is just an investment but legally (and therefore for tax and regulatory purposes it is insurance)
Quota share
Constant apportionment of all premiums and claims between ceder and reinsurer for all risks covered by the treaty
Disadvantages
Treats high variance and low variance risks the same
Treats large and small risks the same
Passes a share of profit to the reinsurer
Advantages
Spreads risk
Encourages reciprocal business
Can improve solvency ratio
Simple to administer
Commission may help with cashflow
Can help new small insurers take on business at all
Constant apportionment of all premiums and claims between ceder and reinsurer for all risks covered by the treaty
Cedant experience
Cedant's loss ratio will be basically the same.
Quota share simply allows small business to take on risk they could not otherwise take on.
Expenses and commissions will have some impact on this
Reinsurer Experience
Reinsurer can refuse to participate in the treaty if not happy with any of the terms of the business.
They could also reduce the commissions payable or set profit thresholds for the payment of commission.
They may insist on being involved in claims handling for large claims as well.
Surplus Reinsurance
Proportion of risk decided by ceder for each risk, subject to terms of treaty
Disadvantages
Administration more complicated than quota share
Unsuitable for personal lines where potential losses are small
Unsuitable for unlimited covers such as motor liability
Advantages
Spreads risk
Insurer can choose to retain some of the risks
Useful where there is a large variety in the nature of the risk
Commission may help with cashflow
Proportion of risk decided by ceder for each risk, subject to terms of treaty
Cedant experience
Cedant can choose which risks it intends to cede
Cedant can retain varying proportions of each risk
Reinsurer Experience
Re-insurer will not experience the same underwriting experience as the insurer
Likely to have a greater share of the larger and more volatile risks
This should be reflected in premiums and commission paid for the business
Surplus Reinsurance - Terminology
Estimated maximum loss (EML)
The largest loss that is reasonably expected to arise from a single risk
Maximum retention
The maximum level of retention for any risk to be included in the treaty
Minimum retention
The minimum level of retention that the reinsurer requires the insurer to hold to prevent them from having too little interest in the risk
Number of lines of cover
This is specified in the contract and is used to calculate the maximum cover available from the reinsurer. It is how many times the max retention that the reinsurer can be liable for, for a given risk
Determination of proportion ceded
For each risk cedant selects the amount of risk it wished to retain between the stipulated minimum and maximum. The number of lines of cover ceded for this risk is then the multiple of the retained risk that is passed to the reinsurer based on the Estimated maximum loss.
Example
A reinsurance treaty for the shipping book has a maximum retention of £5m and minimum retention £1m. The maximum lines of cover available is 20.
The cedant wishes to take on a risk of £55m.
What is the minimum retention on this risk for the cedant?
55m / 21 = £2.62m
What is the minimum number of lines of cover that the cedant will have to pass to the reinsurer?
(55m - 5m) / 5m = 10
Video
Non-Proportional (Excess of Loss)
With XL reinsurance, the reinsurer covers losses exceeding a predefined excess point, usually with a upper limit. The insurer may then purchase multiple additional layers of reinsurance.
Cedant's experience will be different from the reinsurer's. The cedant will typically experience lower volatility than if they were uninsured and the reinsurer would typically experience much higher volatility.
Proportion of risk decided by ceder for each risk, subject to terms of treaty
Disadvantages
Can be difficult to price (tail-distributions)
Reinsurer expects to profit from business so on average reinsurance premiums will exceed recoveries
Advantages
Allows insurer to accept large risks
Can allow more efficient use of capital
Stabilises technical results
Reduces exposure to catastrophe
Terminology
Retention / deductible
The amount of loss retained by the cedant
Hours clause
Used in catastrophe reinsurance - the limit of time for which events can be considered part of the same event. Typically 24 hours to several days.
Increased limit factors
Ratio of the expected loss for a given limit to the expected loss for a basic limit. This would then be applied to the basic premium as a way of simply ratioing up a premium for a larger risk.
Eg if the expected loss for a basic limit of £1m was £100,000 and the expected loss for a limit of £2m was £140,000, then the expected loss cost would be 40% more
Indexed limits
Where inflation could be a significant factor - indexed limits can be used to ensure reinsurer does not get an increasing proportion of risk just because of price changes
Working Layer
First layer above the cedant's retention where significant loss activity is expected. Premiums can vary with claims experience for working layer reinsurance (in a 'no claims discount sort of way').
Reinstatements
These allow treaty to be extended after a number of separate events have exhausted the XL treaty limit
Losses Occurring
These policies cover all claims made where the claim occurred during the period of cover of the reinsurance contract
Risks Attaching
These policies cover all claims made in respect of policies which incepted during the period of cover of the reinsurance contract
Types (Non-Proportional (Excess of Loss))
Risk XL
Protects against large individual losses
Important that the upper limit is sufficiently high
Aggregate XL
Protects against an aggregate amount of losses in excess of a specified amount
Important that the upper limit is sufficiently high
Many different ways of defining policies - much care in policy wording required
Tends to be only for one event causing the large loss - reinstatements then needed after that
Catastrophe XL
Aggregate XL where losses derive from a specific catastrophic event
Much higher level of aggregate cover than aggregate XL
Care needed over definition of single event
Stop Loss
Covers total losses over a given period
Different from Cat and aggregate in that it covers the accumulation from multiple events
Can be monetary amount or percentage of written premiums
Risk XL
Agregate XL and Cat XL
Stop Loss
Video (Excess of Loss)
The following video gives a simple illustration of the de-leveraging of different methods
Better known as cat bonds - insurance companies issue a bond to the capital market which pays a regular coupon and redemption payment
In the event of prescribed catastrophe bond defaults providing relief to insurer
Structured finance
Reinsurers can provide financial guarantee or credit insurance to institutions borrowing from the capital markets
Credit securitisation
The insurer provides an insurance wrapper to some kind of debt instrument. Can be used by banks to provide capital relief or companies to provide credit protection
Credit securitisation - example
Committed capital / contingent capital
The insurer purchases an option to issue its securities at a predetermined price in the event of a prescribed adverse event
Industry loss warranties
This is a contract where the payout is based on the loss incurred in the entire industry, rather than a particular book of business
Run off Reinsurance
Reinsuring risks from business already written and exposed
Largely used in the event of corporate restructuring but may also be used to manage the risk of legislation change or legal rulings etc
Adverse development cover
Typically the reinsurer will underwrite any losses on the book of business which exceed a pre-agreed amount
Cedant may retain some proportion above this amount to avoid moral hazard with payment procedures
Cedant retains liability in the legal sense
Loss portfolio transfer
Liability for a block of business is passed in its entirety to another insurer
Legal liability passes to new insurer as well and may need to be approved by a court
Can improve the credit rating of the cedant and give diversification to the reinsurer
May involve crystallization of assets with tax implications, buy-in from reinsurers or contamination of reputational risk from reinsurer if they default
Retrocession
This is a reinsurance of reinsurance
The cedant is called the retrocedent and the reinsurer is called the retrocessionaire
Specialist area of business, typically excess of loss
Reasons for purchasing retrocession are essentially the same as reasons for purchasing reinsurance
Fronting
This is where the insurer passes all (or nearly all) of the business to the reinsurer and effectively acts as a sales channel
May be a way of getting round licensing and credit rating issues
Also may improve tax efficiency
Fronting company retain the legal liability and should be very confident of the reinsurer
Captives
Insurance companies can set up a captive to self reinsure. This may have legislative compliance or tax advantages
Video
Reserving of Reinsurance
Short tailed business
Generally property, marine and aviation type policies as well as many catastrophe type situations
Generally relatively easy to reserve for using a simple chain ladder or even expected loss ratio approach
Sometimes a more granular approach is taken and claims development may be looked at over months or even weeks so that the timing of catastrophe claims can be analysed more accurately
Medium/long term business
Medium tailed might be construction and high excess property
Long tailed might be casualty aggregate excess or facultative casualty
Chain ladder methods still common with Bornheutter Ferguson or Cape Cod
Results much more volatile and subject to interpretation
Data Issues (reinsurance reserving)
Fundamentally reserving for reinsurance the same as for insurance but there are many more data issues to overcome
Heterogeneity of data
As all the different insurers may have different types of policies and different styles of the same policy then even data that should be homogenous could be quite heterogeneous
There are also relatively few industry benchmarks available for reinsurance data
Sparse data
For high excess infrequent claims there may be very little data on which to base analysis
Grouping
Reinsurers may consider extra data grouping such as business of origin or type of contract
Claims reporting delays
Claims reporting delays longer even for proportional contracts as notification often only required quarterly
For excess of loss there can be many more people in the process before the claim amounts are agreed adding to the time delay
Systems
Reinsurers are reliant on the data provided by the insurer which may be grouped together in ad-hoc ways which vary from insurer to insurer and do not allow easy comparison.
Greater upside risk to claims
This is the case for non-proportional where many claims have a longer period to settlement and can be of a liability nature - so incurring more risk of claims inflation biting in the time it takes for the claim to be settled
Outwards - reinsurance (ie the reinsurance we buy as an insurance company)
A number of methods can be used or a mix of methodologies can also be used
Use data gross and net of reinsurance
Reserve for gross losses as normal and then apply the same methodology to the data net of reinsurance claims
Use standard reserving techniques on claims and premiums
Triangulate reinsurance premium and claims amounts in the normal way and then apply standard reserving techniques to them
Apply broad brush factors to projected gross data
Can be used where proportional reinsurance is being applied and the cession percentage is known in which case it is simple and accurate
Case by case reserving
Simple approach where we only reserve for reinsurance on the largest and most serious claims
Developing individual losses
Fully bespoke approach to every individual loss which is developed to completion and the reinsurance implication are then modeled and calculated so that the reinsurance claims can be calculated exactly
